🇺🇸 Made in America·100% U.S.-Based Team · 24+ Years in Cost Segregation
In 1997, a small team of tax attorneys for Hospital Corporation of America walked into the United States Tax Court in Washington. They were arguing about carpet. And lighting. And electrical panels. The IRS thought every one of those items was part of the building. HCA thought differently. HCA was about to win.
The ruling that came out of that case is called Hospital Corporation of America v. Commissioner. The citation is 109 T.C. 21. Almost no one outside specialized tax circles read it at the time. They should have. That ruling is the reason you, today, can keep hundreds of thousands of dollars that would otherwise have gone to the IRS.
The practice that ruling validated has a name. Cost segregation.
Here is what cost segregation does. When you buy a commercial building, the IRS makes you depreciate it over 39 years. On a $1 million purchase, that is roughly $25,600 per year. Year after year. For 39 years.
But here is what most property owners never get told. Not every part of your building is a building. The carpet is not the building. The dedicated electrical for your specialty equipment is not the building. The parking lot is not the building. The landscaping is not the building. The IRS lets you depreciate those items over 5 or 15 years instead of 39.
A cost segregation study finds those items. It values each one. It documents each one. The IRS lets you take the deduction faster.
Faster matters. Faster matters even more right now. On January 19, 2025, the One Big Beautiful Bill Act restored 100 percent bonus depreciation. Every dollar your study reclassifies into 5-year and 15-year property can be deducted in Year 1. Not over 5 years. Not over 15. Right now. This year.
On a $1 million property, the math typically produces $200,000 to $450,000 of Year 1 deductions you would otherwise have spread over four decades.
That is real money. That is your money. That is money the law already says you can have, if your study is done correctly.
Most property owners do not know any of this. The ones who do know do not always know why it is legal, why it is settled, or why it holds up in an audit. The history below is the answer. It is also the reason The Cost Seg America team has been doing this work for 24 years, completed more than 16,000 studies, and defended 125 IRS audits without losing one or returning a single dollar to the IRS.
The story does not start with the courts. It starts with John F. Kennedy.
In 1962, Kennedy's administration was trying to pull the country out of a recession. Their answer was the Revenue Act of 1962. The bill did three things that matter to this story. It created the Investment Tax Credit, giving businesses a credit of 7 percent on the cost of certain tangible personal property. It enacted Internal Revenue Code Sections 1245 and 1250, which divide depreciable property into two categories. Tangible personal property is § 1245. Real property is § 1250. Those two sections are still the law today.
The ITC mattered. 7 percent of what you spent on qualifying equipment came right back as a tax credit. For businesses making real capital investments, that was meaningful money.
The credit only applied to § 1245 property. Buildings and structural components were excluded. So the IRS had to draw lines. What counted as the building? What counted as personal property installed inside the building?
The lines moved. They moved a lot. Through the 1960s and 1970s, the IRS issued revenue ruling after revenue ruling working through the distinction. An electrical panel powering the whole building was § 1250 real property. An electrical panel dedicated to a specific piece of production equipment was § 1245 personal property. A bathroom toilet was the building. A grease trap for a commercial kitchen was not.
Property owners and their accountants noticed something. The same physical item, sitting in two different buildings doing two different jobs, could be classified two different ways. The classification depended on what the item did.
So engineers got involved. Larger commercial projects started having engineers walk the building. They identified every component. They classified each one. They documented why. The result was a study, sometimes called a component cost allocation, that gave the owner a defensible position for treating some items as personal property and depreciating them faster.
In 1962, Revenue Procedure 62-21 formalized the Guideline Life System for depreciation. In 1972, Revenue Procedure 72-10 replaced it with the Asset Depreciation Range system. The depreciation rules evolved alongside the ITC, with shorter recovery periods generally producing larger annual deductions for taxpayers.
Then 1981 happened. The Economic Recovery Tax Act, signed by Reagan, created the Accelerated Cost Recovery System. ACRS. Recovery periods got shorter across the board. Real property could be depreciated over 15, 18, or 19 years depending on when it was placed in service. The Investment Tax Credit got bigger. By the mid 1980s, ACRS plus the ITC was producing some of the most aggressive depreciation math in American history.
Engineers got busier. Studies became standard practice for any commercial building of meaningful size.
Then, in 1986, Congress took it all away.
On October 22, 1986, Ronald Reagan signed the Tax Reform Act of 1986. The legislation did two things at once. It killed the Investment Tax Credit. And it rebuilt the entire depreciation system.
The new system was called MACRS. Modified Accelerated Cost Recovery System. It is still in use today. Every cost segregation study performed anywhere in the United States in 2026 runs on the class lives MACRS established in 1986.
MACRS sorted assets into specific class lives. For building cost segregation purposes, the classes that apply are:
Note: 7-year MACRS property exists in the broader IRS class life framework but does not apply to building cost segregation. Separately purchased business assets that are not part of the building's depreciable basis are handled by the CPA on the company's books outside of the cost segregation analysis.
That last bucket is where the IRS makes you put your whole building by default. Every component in it. All 39 years. Unless somebody pulls out the items that legally do not belong there.
This is the work.
Cost segregation is the practice of identifying what fits into each MACRS bucket. The 5-year items deduct over 5 years. The 15-year items over 15. Only the items that actually are the building shell sit at 39.
What does that produce? It depends on the asset class. The percentages run like this:
These ranges are not made up. They are what 24 years of doing this work has shown. Each building is different. Each asset class has its own profile.
The Investment Tax Credit was gone after 1986. The depreciation math underneath MACRS turned out to be valuable on its own. Through the late 1980s and early 1990s, a small group of engineering and accounting firms kept doing what they were now calling cost segregation studies.
The IRS did not love it. Many field auditors challenged the studies on examination. There was no controlling precedent, no formal IRS blessing, no standard methodology everyone agreed on. The practice grew slowly because of the uncertainty.
Then a hospital chain in Tennessee decided to fight back.
Hospital Corporation of America was based in Nashville. In 1997 it operated hundreds of hospitals across the country. It also had a large, sophisticated tax department that had been doing component depreciation studies on its buildings for years.
The IRS had been challenging those studies. Over and over. HCA's tax team kept defending them. Eventually the disagreement got too big to ignore. It went to Tax Court.
The case is reported at Hospital Corporation of America v. Commissioner, 109 T.C. 21 (1997). The opinion is referenced by the IRS itself in the current Cost Segregation Audit Technique Guide as the seminal cost segregation case. The court worked through a long list of components inside HCA hospitals one at a time.
The IRS position was simple. Everything attached to the building is the building. 39-year life. No exceptions.
HCA's position was also simple, but came with documentation. Some of these components are not the building. They are tangible personal property installed inside the building. They have their own function. They wear out faster. They qualify for shorter MACRS class lives.
The court ruled mostly with HCA. The opinion allowed shorter recovery periods on items including primary and secondary electrical distribution systems serving specific equipment, accent and decorative lighting, medical gas plumbing, certain carpets and vinyl wall coverings, decorative millwork, kitchen exhaust systems, and a long list of other components.
What made the case important was not just the result. It was the test the court used. The court applied the framework from Whiteco Industries v. Commissioner, the 1975 case that had laid out a 6-factor test for distinguishing real from personal property. The Whiteco factors look at:
HCA applied those factors to every component. The Tax Court accepted the methodology. And in a published opinion that every subsequent court has had to consider.
The IRS issued an Action on Decision (AOD-1999-008) acquiescing to HCA on the principle that the same tests used to qualify property for the ITC also apply to MACRS classification. That acquiescence is what made cost segregation a viable strategy for any commercial property owner, not just hospital chains with big tax departments.
Within months of the HCA decision, the cost segregation field began to grow. Engineering firms partnered with accounting firms to offer formal studies. Property owners who had never thought about depreciation as a strategy began asking for it.
The case law kept building. Walgreen Co. v. Commissioner, T.C. Memo 2002-209, applied the same framework to drugstore locations. Subsequent Tax Court rulings have applied it to additional asset classes. Each case added detail. None reversed the core principle.
The body of case law on cost segregation is now settled. Done correctly, with proper engineering documentation, the methodology works. The question on audit is not whether you can do a study. The question is whether the specific items you classified actually qualify.
Which is where the IRS Audit Technique Guide enters.
The IRS does not prohibit cost segregation. It never has. Instead, the IRS publishes detailed guidance for how its own examiners should evaluate the studies they encounter on audit.
That guidance is called the Cost Segregation Audit Technique Guide. The ATG.
The first version was published in 2004. The IRS has revised it multiple times. There were significant updates in 2017 covering electrical distribution systems. The June 2022 revision reflected the Tax Cuts and Jobs Act of 2017 and the CARES Act, and introduced expanded guidance on Qualified Improvement Property and a number of other technical areas. The current edition is IRS Publication 5653, catalog number 20884M, dated 2-6-2025. It runs hundreds of pages. It is publicly available on the IRS website. It is the most detailed document the IRS publishes on building tax classification.
The ATG identifies six methodologies a cost segregation study can use:
The ATG explicitly identifies Approaches 1 and 2 as preferred. Read that again. The IRS itself, in its own audit guidance, names two methodologies it prefers when its examiners are looking at studies. Two.
Why does this matter? Documentation.
Approach 1 starts with actual construction cost records and assigns every cost to its proper MACRS class. Approach 2 starts with a current engineering survey and estimates costs from that survey. Both produce component-by-component documentation an IRS examiner can verify line by line.
Approaches 3 through 6 produce something more like estimates or averages. The numbers can be defensible. Often they are not. The documentation behind them is weaker. When an examiner picks up the file, there is less to verify.
Studies marketed as software-driven, automated, AI-powered, or rule-of-thumb based are almost always running Approach 5. They are faster to produce. They are cheaper to produce. They are also more vulnerable in audit.
Here is the math underneath. A study built on Approach 1 or 2 identifies every qualifying component individually. A study built on Approach 5 estimates the category total from industry averages. The first method tends to find $60,000 to $150,000 more per $1 million of depreciable basis than the second method. That is the cost of methodology shortcuts.
The Cost Seg America team uses Approaches 1 and 2 on every study. Not most. Every. We have done so for more than 24 years. We have completed over 16,000 studies. We have been audited by the IRS 125 times. We have not lost a single audit. We have never returned a dollar.
That record exists because the ATG was written and we read it. Methodology decides what happens when the auditor opens the file. The IRS told everyone which methodologies it prefers. Some firms listened. Others did not.
The Tax Cuts and Jobs Act of 2017 changed cost segregation in one specific way. It brought back 100 percent bonus depreciation.
Bonus depreciation had been around since 2001. The rates moved up and down with each tax bill. TCJA set the rate at 100 percent for property placed in service after September 27, 2017 and before January 1, 2023.
What that meant: any component your study reclassified into a 5-year and 15-year MACRS class could be deducted entirely in Year 1. Not over 5 years. Not over 15. Year 1. The full amount.
A study that reclassified $300,000 of a property into shorter MACRS classes used to produce, say, $60,000 of Year 1 depreciation. With 100 percent bonus, that same study produced $300,000 of Year 1 depreciation.
The math changed. The behavior changed too. Demand for cost segregation grew sharply through 2018 and 2019. Owners who had let cost seg sit on the shelf reconsidered. CPAs who had not been recommending it started recommending it.
Then the phase-down began. Congress had built it into TCJA from the start. Beginning in 2023, bonus depreciation fell to 80 percent. In 2024, 60 percent. In 2025, was scheduled to go to 40 percent. By 2027, zero.
On January 19, 2025, the One Big Beautiful Bill Act became law. The OBBBA restored 100 percent bonus depreciation permanently for property placed in service after that date.
This is where we are today. As of January 19, 2025, every dollar your study reclassifies into a 5-year and 15-year MACRS class is deductible in Year 1. Not over time. Right now.
Run the math.
On a $1 million property, a typical reclassification rate of 25 to 40 percent produces $250,000 to $400,000 of Year 1 deduction. If you are in a 37 percent marginal tax bracket, that is roughly $92,000 to $148,000 in actual tax savings. Cash kept. Cash you would have paid the IRS otherwise.
On a $2 million property, double those numbers. On a $5 million property, multiply by 5.
The math today is the strongest it has ever been in the history of cost segregation.
If you bought, built, or significantly renovated a commercial property in the last 10 years, you can still benefit. The catch-up depreciation gets claimed through Form 3115. Standard rule: your CPA files the 3115 as part of their regular work. If your CPA does not want to handle it, our team can refer the matter to a partner CPA who specializes in cost segregation 3115 filings for a separate fee.
When was cost segregation first allowed?
The roots trace back to the Investment Tax Credit enacted in the Revenue Act of 1962. The modern methodology was validated by the Tax Court in Hospital Corporation of America v. Commissioner (109 T.C. 21, 1997) and the IRS officially acquiesced in Action on Decision AOD-1999-008 in 1999. The IRS first published its Cost Segregation Audit Technique Guide in 2004. The current edition is Publication 5653, dated February 6, 2025.
Is cost segregation a tax loophole, and what changed under OBBBA?
No, it is not a loophole. Cost segregation is the proper application of MACRS class lives that Congress wrote into the Tax Reform Act of 1986. The IRS publishes 347 pages of guidance on how to perform the work correctly. On January 19, 2025, the One Big Beautiful Bill Act restored 100 percent bonus depreciation permanently for qualifying property placed in service after that date. Every component a study reclassifies into a 5-year and 15-year MACRS class can now be deducted in full in Year 1 rather than spread over the recovery period.
Why does methodology matter so much?
The IRS Audit Technique Guide names Approaches 1 and 2 (detailed engineering from actual cost records or from a current engineering survey) as preferred. Approaches 3 through 6 produce weaker documentation and are more vulnerable in audit. Studies marketed as software-driven or AI-powered typically run Approach 5. They are faster and cheaper but harder to defend if the return gets examined.
Here is the truth about cost segregation that the history makes clear.
It is not a tax loophole. It never was. Loopholes get closed. Cost segregation has been validated by the Tax Court in HCA and confirmed in case after case since. The IRS itself published Publication 5653 to tell its own examiners how to evaluate studies. The methodology is settled law.
It is not aggressive tax planning. It is the proper application of MACRS class lives that Congress wrote in 1986 to the actual components inside your specific building. The deduction is already authorized by the law. A study just claims what the law already allows.
It is not optional, exactly. If you own commercial real estate and you are not doing cost segregation, you are voluntarily paying more tax than the law requires you to pay. That is not strategy. That is leaving money on the table.
What you have to decide is whether you want a study built on the IRS-preferred methodology, or one built on a shortcut. The result on paper might look similar. The result on audit will not. The result over the life of the property will not either.
The Cost Seg America team has been performing engineered cost segregation studies for more than 24 years. 16,000 studies. 125 IRS audits defended. Zero losses. $0 ever returned to the IRS. Every study uses IRS Approaches 1 and 2. Every study is engineered, not estimated. Flat fee. 100 percent U.S.-based team. The average first-year savings across the 16,000+ completed studies is $438,511. Unlimited audit defense included. Written responses and phone representation. No time limit. No hour cap. No additional fee. Ever. Made in America, by Americans.
If you own a commercial property and want to find out what cost segregation would do on it, the next step takes 30 seconds.
Send us the property address and the approximate purchase price. We send back a free preliminary proposal within 24 hours. The proposal tells you your estimated Year 1 deduction, the methodology we would use, the timeline, and the flat fee. No obligation either way.
Email: info@costsegamerica.com Phone: 1-888-365-5023 Online: costsegamerica.com/free-proposal
The history of cost segregation says the law is on your side. The 2025 OBBBA says the math is the strongest it has ever been. Publication 5653 tells you exactly how the IRS expects the work to be done. Whether you do something about that is up to you.
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